Real Estate Financing 101

Money Doesn’t Grow on Trees –
So Where Should You Look?

It is possible to get into the real estate investing business with very little or no cash. You can be a dealer – someone who finds bargain properties, signs purchase contracts with the homeowners, and then sells the contracts to more well-heeled investors – with very little capital. You can be a scout – someone who simply turns other investors on to bargain properties in exchange for referral fees – with literally no money at all. But when you’re ready to take your real estate investing career to the next level, you will need access to cash. The good news is that money is easier to come by today than at any other period in human history – you just have to know where to look for it.

Borrowing From a Bank or Other Mortgage Lender

Loans from banks and other traditional mortgage lenders are collectively known as institutional financing. Institutional lenders make loans based on the borrower’s credit history and income, more so than the value of the property at hand. This doesn’t mean that you’ll be unable to obtain financing if you have some blemishes on your credit report, but it does mean that you’ll probably be paying a higher interest rate and you may be required to put more money down.

If you’re planning on flipping a property in a matter of months, the interest rate on your loan is essentially irrelevant. What you do need to pay attention to is a little thing called “points” – which is just a sneaky term for lender profit. Each point is equivalent to 1 percent of the loan amount, so 1.5 points on a $100,000 loan would be $1,500. You pay these points regardless of how quickly you flip the property, so they can really cut into your return on investment. Also, be on the lookout for other hidden charges such as origination fees and underwriting fees and be sure to take these into account when calculating your anticipated profit. You may find out that with all the fees an institutional lender wants to charge you, you would be better off looking elsewhere for financing.

Borrowing From Your Uncle Rich (or Other Rich Uncle)

Borrowing from a family member is another option for some beginning investors. Perhaps you have a wealthy grandmother who would like to give you a helping hand with a zero percent interest loan. Or maybe your brother is willing to front you some short-term cash for a share of your profits. Either way, you obviously must consider potential consequences to your relationship before accepting the loan – particularly if you are seeking out your family member’s help.

The good news is that there are now several companies that administer inter-personal loans. These firms can mitigate the discomfort and awkwardness of family loans by handling the dirty work of sending payment reminders and collecting the cash. If you’re interested in having a third-party administer your personal loan, do an internet search and evaluate the various companies that provide this service. The industry leader is Circle Lending (www.circlelending.com) but there are numerous alternatives – find the one that works best for you.

Hard Money

If you look in the “Real Estate Classified” section of your local newspaper, you will probably find ads for private moneylenders. Their ads are usually very direct and to the point – hard money lenders are strictly business! And it’s quite a profitable business they have, with exorbitant interest rates and egregious fees – 18 percent APR with 5 points in fees is not unheard of. So are these hard money lenders worth using, or are they the real estate equivalent of payday loan shops, preying on suckers with bad credit?

Believe it or not, there are several advantages to using hard money. For one, oftentimes they don’t even bother checking your income or credit history. To many hard lenders, these factors are irrelevant – all they care about is the value of the property you intend to buy. This not only serves as a wonderful option for people with poor credit, but it also ensures that deals get done more quickly. Secondly, hard money lenders make loans based on the market value of a property, whereas institutional lenders typically base their loan amounts on the selling price or the market value, whichever is less. So while a hard money lender may be willing to loan you as little as 50 percent of the market value, that amount could be as much as 80 percent of your purchase price if you find a really great deal.

Other Financing Options

Other sources of money include your credit cards, credit lines, home equity loans, and home equity lines of credit (HELOCs). While these are generally not good sources of long-term financing, they can be great options for a down payment or the entire purchase price of a property you plan to quickly flip to another buyer.

One new source of money made possible by the internet is “peer-to-peer lending,” which matches individual borrowers and lenders via the web. Prospective borrowers create an ad listing, much like an eBay auction. They state the purpose of the loan, the amount that they are requesting, and the maximum interest rate that they are willing to pay. The loan administrator runs a credit check on the borrower and displays the findings to the prospective lenders, who competitively bid to fill the loan. If this form of financing interests you, do an internet search for “peer-to-peer lending” and check out the various companies providing this service.

Finally, seller-financing is the best money source of all – so much so that it deserves an article of its own. However, since seller-financing is not always a possibility, it is important to be aware of the myriad of money sources that are available to real estate investors of all experience and income levels. You just need to know where to look!